Commodities | May 25 2010
This story features BLUESCOPE STEEL LIMITED. For more info SHARE ANALYSIS: BSL
By Chris Shaw
From an April peak of around US$185 per tonne, spot iron ore prices in China have fallen to a current price of about US$152 per tonne. Citi suggests the decline is a reflection of buyers stepping back to assess government measures aimed at cooling the property market.
In Citi's view the fall in prices is likely to prove to be only a temporary pause, as over the next two to three years it sees the Chinese market as remaining in a state of under-supply. This sets the scope for prices to average US$150-$200 per tonne during that period in the broker's view.
Citi's time-line for stronger prices is broadly in line with that of BA Merrill Lynch, the latter not expecting significant downward pressure on prices prior to 2013. In part this is because of a view the ongoing growth in Chinese crude steel production is generating higher domestic iron ore output, but this is generating a fall in average grades.
As BA Merrill Lynch notes, falling grades are causing an increase in cost pressures, a trend it expects will underpin robust spot prices for the medium-term. Given this view the broker sees upside risk to its price forecasts in the final quarter of this year and into 2011, which currently stand at US$110 per tonne and US$107 per tonne respectively.
The short-term story is a little different though, as BA Merrill Lynch notes while spot iron ore prices have fallen 20% in recent weeks more declines are likely in coming months given the current increase in demand uncertainty.
According to Citi's estimates, 50-55% of China's steel use is in the construction sector. This means any moves by the Government to cool the property sector are likely to impact on steel and therefore iron ore demand.
As BA Merrill Lynch points out, in a tight market spot import prices tend to exceed spot domestic prices, but as conditions have changed in China in recent weeks this price differential has narrowed. With additional seaborne supply available and steel production growth moderating the broker expects spot prices will continue to ease.
From a forecast spot fines price of US$178 per tonne for the second quarter, BA Merrill Lynch sees prices sliding to US$120 per tonne in the third quarter, then US$110 per tonne in the fourth quarter. As noted above the broker suggests price risk is to the upside in the fourth quarter.
As spot prices fall BA Merrill Lynch expects quarterly price settlements will come under pressure, the most likely outcome being buyers default on quarterly contracts to buy material at cheaper spot prices. This suggests the next round of price negotiations is likely to see prices default to spot levels.
If this is the case Citi remains more bullish on prices than does BA Merrill Lynch, Citi's forecasts calling for spot iron ore prices of US$130 per tonne in both the third and fourth quarters of this year and through 2011.
In the steel sector Deutsche Bank notes prices have remained flat over the past week or so, while at the same time the Australian dollar has declined from US87c to US83c. With spot steel and iron ore prices above its forecasts, the broker suggests the currency movements imply some upside to earnings estimates for both BlueScope Steel ((BSL)) and OneSteel ((OST)).
On current spot prices Deutsche suggests its FY11 forecasts for BlueScope would rise by around 7% compared to its current forecast, while for OneSteel the increase would be around 4%. In both cases the magnitude of the changes applies to EBITDA (earnings before interest, tax, depreciation and amortisation) estimates.
Deutsche is already above market with respect to its forecasts for both companies, as for BlueScope it expects earnings per share (EPS) of 5.9c this year and 24.9c in FY11, compared to what is notes are consensus estimates of 4.7c and 21.3c. For OneSteel, Deutsche is forecasting EPS of 18.1c this year and 43.7c in FY11, while consensus estimates stand at 18.1c and 39c.
In terms of ratings, Deutsche Bank has both BlueScope and OneSteel as Buys, with BlueScope its pick of the sector. Overall the FNArena database shows BlueScope is rated as Buy eight times and Hold twice with an average price target of $3.50, while OneSteel is rated as Buy four times, Hold five times and Sell once with an average target of $4.35.
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